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economies of scale

  The cost advantages gained by large-scale production, as the average cost of production falls with increasing output. Total production costs usually increase less than proportionately with output, up to a point where diseconomies of scale (cost disadvantages) set in.

Economies of scale generally arise from conditions internal to the operation of the plant in question. Some important internal sources of scale economies are: (a) indivisibilities, where plant is built to a certain capacity below which the average cost of production will be higher than at full capacity, and the plant cannot be divided up into smaller units working with the same efficiency as the larger one; (b) specialization and division of labour associated with expansion of scale, which can increase efficiency and hence lower costs; and (c) overhead processes, such as the design of a product, which must be undertaken and paid for irrespective of scale so that the larger the output the lower the overhead cost per unit. Certain external economies may also be associated with expansion of scale of output, e.g. if the growth of an entire industry reduces costs in each individual firm.

The existence of economies of scale encourages the expansion of productive capacity up to the point where diseconomies eventually pull the cost of the additional (marginal) unit above the price that it will fetch. In some modern industry it may be that this point is reached only at a very high volume of output; thus average cost continues to fall with rising output well beyond the level at which diseconomies might be expected to arise. However, in other activities a trend towards more flexible and differentiated production may lead to diseconomies at relatively small scale of output. (See also economies of scope.) (DMS)



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